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The Price Comparison Paradox

by David Smith

November 23, 2015

Price comparison websites have sung and danced their way into our lives over the last 20 years. A close look at their business model gives interesting insights into the reasons why consumers and regulators are now starting to question them.

Free Lunch Anyone?

On my way to the market in Marrakech, I stopped my car at a red light and out of the buzzing traffic, a young man emerged on a scooter.

He offered to show us around the market for free. It seemed like a stroke of luck. His local knowledge, where we were mere tourists, could be useful. But something made me decline his offer.

“3. Nothing is free! … If someone offers to show you around for “no money”, you may be led to quiet areas of Marrakech, and find your guide difficult to shake off…”

It appears the wise writers at Trip Advisor were not the first to come up with this idea

The phrase “No free lunch” seems equally appropriate when considering the problems faced by price comparison websites (PCWs)- the official market guides of the internet.

They offer an information service at no cost to the consumer, a guide through the myriad of specialised, complex deals.

They have all of the data and calculators needed to reduce the comparison of the market’s offerings to minutes rather than hours.

Enticingly, it is all presented to us by some adorable talking rodent, or robot, or whatever. In blissful ignorance, we go for the free lunch.

PCWs provide services (the proverbial lunch) free of charge to us and we usually don’t ask any questions. I mean, why question it? It’s free!

Unfortunately, PCWs have been catching a lot of flack recently. And just when you thought it was safe to go back to energy shopping, the energy industry regulator (Ofgem) launched a full-scale Chapter 1 investigation into the sector.

The subject? Possible unsavoury practices in selling energy deals. Perhaps there really is no free lunch after all.

Money Talks

The problems start to emerge when we begin to ponder that PCWs are not just working for us.

The PCWs may be free for consumers, but someone must be picking up the tab. And I bet you can guess who that is.

The PCW’s bread and butter comes from their other customers - the suppliers. Commission payments are made whenever you buy their products via the PCWs. Since they don’t charge us, PCWs have to be a commission-driven marketing channel for the companies.

PCWs have to offer us free, impartial advise and please their paying customers — the suppliers who list product with them — at the same time

The commission levels with each company vary from £5 to £30 per fuel (usually two of these are involved in a switch). Then there are negotiated bonuses and sales targets.

PCWs don’t have commission agreements with every company, so selling some deals pays them £0, but selling others can net them £60.

So money may always tempt the PCW to promote the deals that them pay more commission. Their profit incentive grinds away at their commitment to being unbiased. But, how did it get this way?

When they began their lives, PCWs needed to decide on a way to sustain themselves. They chose to be paid by the companies who’s offerings they promote, so they could attract more visitors faster by making their websites free to use.

The PCW business model can also be explained by history. PCW’s were invented by marketers, having originally been spun out of businesses where salesmen went door-to-door convincing people to switch their provider for commission.

The Paradox

The PCWs conflict of interest leads to an absurd paradox.

Being ‘Impartial’ and ‘Free’ is like being ‘Single’ and ‘Married’, or ‘Labour’ and ‘Conservative’.

It’s perfectly reasonable to exist as one, but not really possible to be both. Here’s why:

‘Impartial’ means that PCWs will be unbiased in their recommendations. They will not lead us into deals from one supplier over another any reason other than our own good. They will fulfil their promise of saving us money.

‘Impartial’ isa commitment to transfer money away from suppliers.

‘’Free’ — in this case we know means “Paid for by the suppliers”. So suppliers are paying to fund a service that is designed to make them lose money?

Energy suppliers are far smarter than this snake. So why pay PCW’s?

Suppliers aren’t just benevolently funding PCWs with hundreds of millions of pounds because they are nice people. They are paying for a service.

‘Free’ is a commitment to transfer money to the suppliers.

PCWs commit to a contradiction, which if they fulfilled, would make them disappear

This seems absurd… and it is. Herein lies the “Price Comparison Paradox”.

Suppose PCWs were highly effective at helping consumers to identify and switch to the best deals. The majority of suppliers (knowing that they themselves rarely offer the best deals) would receive no business from them and would soon refuse to continue the commission agreements.

This gets us to the bizarre conclusion that if price comparison sites worked very effectively for consumers, their income would dry up and they would quickly cease to exist.

Death by a thousand regulations?

The energy regulator Ofgem has launched a number of initiatives to tackle problems in the price comparison industry, like the Confidence Code for energy comparison sites.

Regulation is a way of trying to enforce the ‘Impartial’ part of the promise with laws.This has been a challenging task.

In response to the difficulties, the government has launched investigations in various flavours. Not only is Ofgem investigating PCWs, Ofgem are themselves being investigated by the CMA (The Competition and Markets Authority).

In preliminary results Ofgem were found to have an Adverse Effect on Competition (the dreaded “AEC”, there is no worse insult to a regulator).

Change could be afoot, but it’s still early days.

‘Freeness’ and ‘Impartiality’ being balanced expertly by Suppliers and PCWs, using Ofgem’s regulatory framework.

The future is currently unclear for Ofgem as well as the PCWs.

If Ofgem has to tighten its grip, they will be faced with the difficult task of regulating an industry with issues that go down to its business model. If it has to regulate the sector into fairness, it risks deepening it’s anti-competitive effect. If it steps back, consumers are left helpless. Unfortunately, I can’t see many available moves to Ofgem or suggest useful solutions for them. We continue to watch the situation develop with great interest.

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